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A.'S’Jp 

. Wut 

V. ^ 

Knowledge  of  Investment 


By 


Charles  Lee  Scovil 

Representing 

Spencer  Trask  & Co. 


Spencer  Trask  & Co. 

43  Exchange  Place,  New  York 

Albany,  N.  Y.,  State  and  James  Streets 
Boston,  Mass.,  50  Congress  Street 
Chicago,  111.,  115  Adams  Street 


THE  TROW  PRESS 
NEW  YORK 


U^evce 


Contents 


./ 


Chapter  I page 

Saving  and  Investing 1 

Security  of  Principal 3 

Excessive  Rates  of  Interest 5 

Misleading  Statements 7 

Distribution  of  Securities 9 

Mortgage  and  Deed  of  Trust 11 

Chapter  II 

Coupon  and  Registered  Bonds 15 

When  Bonds  are  Lost 19 

Redeemable  Bonds 21 

Sinking  Fund 22 

Forms  of  Bonds 24 

“And  Interest”  Prices 28 

Payment  and  Delivery  of  Bonds 30 

Chapter  III 

Management  of  Corporations 32 

Rights  of  Common  Stockholders 34 

Surplus  Reserve 35 

Chapter  IV 

Preferred  Stocks 39 

Diversification  of  Investments 40 

Best  Issues  of  Preferred  Stocks 40 

(? 


49371 


CHAPTER  I 


SAVING  AND  INVESTING  MONEY 

The  selection  of  sound  investments  is 
largely  a matter  of  education.  It  is  a sub- 
ject deserving  of  careful  study  by  every- 
one, but  especially  by  those  whose  habit 
it  may  be  to  save  some  part  of  their  earn- 
ings, by  people  dependent  upon  income, 
or  by  business  concerns  appreciating  the 
wisdom  of  creating  a surplus  reserve  fund. 

No  man  can  foretell  at  what  time  or 
under  what  circumstances  he  may  cease  to 
be  a factor  in  the  activities  of  this  world. 
It  is  therefore  wise  for  him  to  familiarize 
the  immediate  members  of  his  family  with 
the  subject  of  investment.  Otherwise,  as 
frequently  happens,  they  may  be  per- 
suaded to  invest  in  hazardous  schemes  the 
money  accumulated  solely  for  their  future 
benefit.  If  the  judicious  investment  of 
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money  were  a topic  of  discussion  in  the 
home,  people  would  be  slow  to  employ  their 
funds  in  unsafe,  untried  or  highly  specu- 
lative investments. 

Then  again,  there  are  men  who  are 
large  earners  of  money,  and  who,  appar- 
ently without  any  uneasiness  of  mind,  ab- 
solutely ignore  the  necessity  of  saving  and 
investing  any  part  of  their  income.  It  is 
also  a fact  that  men  often  believe  them- 
selves to  be  investing  money,  when  they 
are  simply  turning  it  over  to  irresponsible 
people,  who  may  employ  little,  if  any,  of 
the  cash  in  a legitimate  enterprise. 

Those  who  do  not  save  and  invest 
money  in  times  of  prosperity  fail  to  for- 
tify themselves  against  the  day  of  adver- 
sity. Thus,  everyone  should  be  careful 
not  only  to  save,  but  also  to  acquire  the 
greatest  possible  knowledge  of  investment ; 
its  affiliation  with  progress  and  prosper- 
ity, and  its  direct  bearing  upon  the  wel- 
fare of  all  people.  Our  railroads,  our 
public  utility  and  industrial  corporations 
— in  fact,  the  bone  and  sinew  of  every 
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successful  industry — is  the  result  of  in- 
vestment. The  Government  itself  rests 
largely  upon  this  foundation.  It  takes 
money,  the  money  of  individuals  collec- 
tively, to  finance  and  maintain  all  of  these 
interests,  and  while  it  will  always  be  true 
that  some  investments  are  more  specula- 
tive than  others,  there  are  comparatively 
simple  ways  by  which  people  with  savings 
or  surplus  may  avoid  the  pitfalls. 

Security  of  Principal 

It  is  generally  recognized  that  in  times 
of  great  prosperity  large  sums  of  money 
are  employed  in  the  purchase  of  undesir- 
able investments.  The  two  chief  reasons 
are  as  follows: 

First:  The  high  cost  of  living  causes 
many  investors  to  give  too  much  thought 
to  the  amount  of  their  income,  thus  neg- 
lecting one  of  the  fundamentals  of  sound 
investment,  which  is  security  of  principal. 

Second:  The  high  prices  commanded 
by  raw  materials  and  manufactured  prod- 


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ucts  lead  men  to  believe  that  larger  profits 
could  be  made  if  sufficient  capital  were 
available  to  permit  of  business  expansion. 
In  many  instances,  these  profits  are  based 
largely  upon  estimated  results  and  dreams 
of  the  future.  As  time  goes  on,  and  the 
inevitable  decline  in  the  volume  of  general 
business  takes  place,  with  lower  range  of 
prices  all  along  the  line,  the  uninformed 
investor,  who  may  have  placed  a part  of 
his  money  in  such  enterprises,  finds  him- 
self to  be  the  owner  of  securities  from 
which  little  or  no  income  is  to  be  derived, 
and  for  which  there  is  practically  no  mar- 
ket. In  other  words,  the  investments  can- 
not be  converted  into  cash  without  an 
unreasonably  large  loss  of  principal.  It 
is  only  after  experiences  of  this  kind  that 
many  investors  learn  this  basic  principle 
of  safeguarding  money:  Look  -first  to  the 
intrinsic  value  of  the  security. 

This  does  not  mean  that  it  is  difficult  to 
make  desirable  investments  in  times  of 
great  prosperity.  On  the  contrary,  dur- 
ing such  periods  many  long  established 
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and  sound  corporations,  with  whose  se- 
curities well-informed  investors  are  fa- 
miliar, find  it  expedient  to  become  heavy 
borrowers.  This  may  be  due  to  the  neces- 
sity for  enlarged  facilities  to  meet  the  in- 
creasing demands  of  a business.  If  in- 
terest rates  are  high,  which  is  usually  the 
case  at  such  times,  the  corporations  have 
to  sell  their  securities  at  prices  which 
will  attract  capital.  It  is  then  that  the 
well-informed  investor,  guided  by  the  ad- 
vice of  his  investment  banker,  is  in  a posi- 
tion to  take  advantage  of  the  opportunity 
to  obtain,  with  safety,  a liberal  return  on 
his  money.  Naturally,  when  interest  rates 
again  become  normal,  the  investments  may 
be  expected  to  appreciate  in  market 
value. 

Excessive  Rates  of  Interest 

I have  no  intention  of  dignifying  by 
comparison  with  judicious  investment,  cer- 
tain classes  of  speculative  real  estate,  min- 
ing stocks  and  numerous  other  similar 
propositions,  all  of  which  are  to  be  con- 
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sidered  as  entirely  apart  from  the  field  of 
legitimate  investment.  At  the  same  time, 
in  view  of  the  large  sums  of  money  lost  in 
such  ventures,  it  is  difficult  to  conceive 
how  any  explanation  of  investment  can 
ignore  some  brief  reference  to  this  deplor- 
able condition.  I therefore  caution  the 
reader  against  having  anything  to  do  with 
such  propositions. 

If  the  vast  amount  of  securities  which 
it  is  claimed  will  yield  anywhere  from 
eight  to  fifty  per  cent  annual  income,  were 
investments  of  sound  and  progressive 
value,  the  promoters  would  experience  no 
difficulty  in  securing  capital  from  respon- 
sible bankers.  Therefore,  when  you  are 
offered  securities  with  the  promise  of  an 
excessive  return  on  your  money,  remember 
that  the  reputable  investment  banker,  with 
his  knowledge  and  special  facilities  for 
investigating  property  values,  is  unable  to 
get  for  his  clients  sound  investments  yield- 
ing more  than,  approximately,  four  to  six 
per  cent.  This,  of  course,  applies  more  es- 
pecially to  high-grade  or  good  investment 
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bonds.  On  the  other  hand,  responsible 
investment  banking  firms  are  sometimes 
able  to  offer  their  clients  well  secured 
1 preferred  stocks  yielding  a return  of, 
approximately,  seven  per  cent.  Investors 
should  bear  in  mind,  however,  that  bonds 
usually  represent  fixed  property ; pre- 
ferred stocks,  quick  assets ; common 
stocks,  surplus  earnings  and  good-will. 
When  preferred  stocks  have  no  mortgage 
or  bonded  debt  ahead  of  them  and  none 
can  be  created  without  the  consent  of  at 
least  a majority  of  the  preferred  stock 
outstanding,  and  when  they  are  preferred 
both  as  to  assets  and  dividends  over  com- 
mon stock,  they  partake  of  many  of  the 
characteristics  ordinarily  found  in  bonds. 

Misleading  Statements 

Investors  are  sometimes  misled  by  the 
statement  that  subscriptions  for  securities 
will  be  received  through  the  medium  of 

1 Preferred  Stocks  of  this  type  are  discussed  on 
pages  39-42. 


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certain  banks  or  trust  companies.  Too 
often,  it  is  the  object  of  promoters  to  take 
this  means  of  inspiring  the  confidence  of 
prospective  investors.  Therefore,  it  is 
well  to  bear  in  mind  that  so  long  as  a com- 
pany offering  its  securities  direct  to  the 
public,  is  without  bad  reputation,  a bank 
or  trust  company  with  which  it  carried  a 
reasonably  large  deposit  account  might 
feel  justified  in  permitting  the  use  of  its 
name  in  this  way,  without  in  any  sense  as- 
suming a sponsorship  for  the  investment. 

Another  thing  to  remember  is  this:  a 
company  selling  its  securities  direct  to  the 
public  is  really  conducting  two  branches 
of  business,  entirely  separate  and  distinct 
from  each  other.  It  is  enough  of  a prob- 
lem in  itself  in  these  days  to  successfully 
and  profitably  transact  a mercantile  busi- 
ness, without  attempting  to  combine  with 
it  the  sale  of  stocks  or  bonds.  A company 
trying  to  do  both  of  these  things  might 
be  successful  in  either  one  of  them,  but  it 
is  frequently  true  that  the  profit  derived 
by  insiders  from  the  sale  of  the  securities 
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at  exorbitant  prices  results  in  the  neglect 
of  the  regular  business  of  the  company. 
Then  again,  in  the  distribution  of  securi- 
ties, it  should  not  be  merely  a question  of 
selling.  On  the  contrary,  one  of  the  most 
important  considerations  should  be  the  per- 
manent protection  of  investors  who  may 
employ  their  money  in  the  purchase  of 
them. 

Distribution  of  Securities 

This  will  explain  why  investment  bank- 
ing firms  of  the  highest  type,  specializing 
in  the  business  of  investment,  are  the  nat- 
ural medium  through  which  well-managed 
corporations  sell  their  securities  to  the 
public.  The  facilities  which  these  firms 
have  for  the  wide  distribution  of  securi- 
ties, not  only  popularize  the  issues,  but 
broaden  the  market  for  them.  While  this 
is  a most  desirable  condition  from  the 
standpoint  of  investors,  it  is  of  great 
benefit  to  the  corporations,  because  the 
market  position  of  the  securities  would 
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warrant  the  sale  of  subsequent  issues  at 
higher  prices  than  would  be  otherwise  pos- 
sible. 

Usually,  the  investment  firms  are  rep- 
resented on  the  board  of  directors  of  the 
corporations,  although  many  houses  rec- 
ommending and  dealing  in  the  securities 
of  large  railroads  and  corporations,  whose 
issues  are  known  the  world  over  and  ac- 
tively traded  in  on  the  New  York  Stock 
Exchange,  do  not  have  this  representa- 
tion. In  fact,  as  the  affairs  of  such  cor- 
porations are  more  or  less  a matter  of 
public  knowledge,  the  responsibilities  of 
those  firms  having  representation  in  the 
directorate  are  not  ordinarily  so  great  as 
in  the  case  of  smaller  public  utility  and 
industrial  corporations,  whose  securities 
are  not  always  listed,  or,  if  listed,  are 
closely  held  by  investors,  and  rarely  traded 
in  on  the  New  York  Stock  Exchange. 
These  issues  are  commonly  known  as  the 
“ specialties  99  of  the  investment  firms  un- 
derwriting them,  and  it  is  essential  that 
the  bankers  recommending  the  securities 
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be  identified  with  the  management  of  the 
properties.  Therefore,  it  is  the  custom 
for  a member  of  the  firms  to  become  a di- 
rector in  the  corporations,  with  the  result 
that  investors  have  a direct  representative 
constantly  watchful  of  their  interests. 

No  responsible  investment  firm  would 
agree  to  purchase  an  issue  of  bonds  until 
the  physical  and  financial  condition  of  the 
corporation  had  been  thoroughly  investi- 
gated, not  only  as  to  past  and  existing 
conditions,  but  also  as  to  future  possibili- 
ties. The  examinations  are  made  by  well- 
known  engineers,  expert  accountants,  and 
men  trained  in  the  actual  operation  of 
the  business  itself.  If  the  investigations 
are  favorable,  and  the  legality  of  the  issue 
approved  by  competent  attorneys,  the 
banking  firm  will  then,  and  only  then,  un- 
derwrite the  issue. 

Mortgage  and  Deed  of  Trust 

Furthermore,  a “ Mortgage  and  Deed 
of  Trust  ” is  framed  between  the  issuing 

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company  and  a trustee — the  latter  usu- 
ally a well-known  trust  company,  having 
a reasonably  large  capital  and  surplus. 
Under  the  terms  of  the  indenture,  which 
are  reviewed  in  detail  by  the  bankers  and 
their  attorneys,  the  issuing  company 
conveys  and  assigns  unto  the  trustee  all 
of  the  property,  rights,  franchises,  etc., 
upon  which  the  bonds  are  to  be  a mort- 
gage. It  also  specifies,  among  other 
things,  the  amount  of  bonds,  and  the  con- 
ditions under  which  they  may  be  issued,  a 
description  of  the  property  mortgaged, 
the  keeping  of  the  same  insured  and  in 
repair,  and  numerous  other  important 
stipulations  designed  to  protect  the  bond- 
holders. In  addition,  it  is  usually  speci- 
fied that  if  default  shall  be  made  in  the 
performance  of  any  agreement  contained 
in  the  indenture,  or  in  the  payment  of  in- 
terest upon  any  of  the  outstanding  bonds, 
and  shall  so  continue  for  the  term  speci- 
fied (usually  from  three  to  six  months), 
the  whole  amount  of  bonds  outstanding 
then  becomes  due  and  payable,  in  accord- 
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ance  with  the  terms  of  the  deed  of  trust. 
In  order  that  all  of  the  holders  of  out- 
standing bonds  may  receive  the  same  fair 
and  impartial  treatment,  united  action 
upon  their  part  is  essential.  It  is  there- 
fore usually  customary  to  specify  in  the 
deed  of  trust  that  while  the  trustee  may 
enforce  the  rights  of  all  bondholders  at 
the  written  request  of  holders  of  only 
from  twenty-five  per  cent  to  thirty  per 
cent  of  the  bonds  outstanding,  at  the  same 
time,  it  takes  a majority  of  the  bondhold- 
ers (from  sixty  to  ninety  per  cent  as  the 
case  may  be)  to  direct  and  control  the 

action  of  the  trustee  in  the  sale  of  the 

property,  or  in  the  appointment  of  a re- 
ceiver to  operate  it  for  their  benefit.  This 
would  prevent  the  sale  of  the  property  at 
a price  which  might  be  considered  a sac- 
rifice. 

On  the  other  hand,  if  the  form  of  se- 
curity to  be  issued  were  stock,  it  is  ob- 

vious that  the  corporation  would  have  to 
be  controlled  by  the  clients  and  friends 
of  the  investment  banker,  because  no  re- 

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liable  firm  would  finance  a corporation 
unless  the  positive  assurance  were  given 
that  it  would  be  in  a position  to  protect 
the  interests  of  its  clients,  no  matter 
through  what  future  exigencies  the  cor- 
poration might  pass. 

These  facts  should  serve  to  explain  why 
responsible  investment  firms  are  recog- 
nized as  being  the  only  proper  channel 
through  which  to  buy  or  sell  security 
issues.  The  service  rendered,  which  is 
largely  professional  in  its  scope,  is  the 
governing  factor  with  the  reputable 
banker,  and  is  so  recognized  by  all  well- 
managed  corporations.  It  is  a service 
which  is  essential  to  the  individual  invest- 
or, aiding  him,  so  far  as  the  experienced 
mind  can  determine,  in  selecting  safe  and 
profitable  investments. 


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CHAPTER  II 


COUPON  AND  REGISTERED  BONDS 

Generally  speaking,  bonds  represent 
a mortgage  divided  into  several  parts,  and 
in  most  cases  the  interest  is  payable  semi- 
annually. The  denominations  are  usually 
$1,000,  although  sometimes  they  are  is- 
sued in  smaller  or  larger  amounts.  There 
are  three  distinct  forms  of  bonds,  as  fol- 
lows: 

Coupon  bonds , 

Coupon  bonds  registered  as  to  principal 
only , 

Bonds  registered  as  to  both  principal 
and  interest . 

It  is  very  important  for  investors  to 
know  just  what  these  different  forms  sig- 
nify, notwithstanding  that  in  all  cases  the 
issuing  companies  are  responsible  for  the 
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punctual  payment  of  the  principal  and 
interest. 

Coupon  bonds  “ pass  by  delivery,”  as  is 
usually  specified  in  mortgages.  In  other 
words,  as  the  principal  and  interest  become 
due,  both  are  payable  to  bearer.  The  bond 
itself  recites  upon  its  face  the  obligation  of 
the  issuing  company,  etc.,  and  has  attached 
thereto  small  interest  certificates,  commonly 
known  as  “ coupons.”  Assuming  that  a 
$1,000  coupon  bond  is  one  of  an  issue  hav- 
ing twenty  years  to  run  before  the  prin- 
cipal becomes  payable,  and  that  it  bears 
interest  at  the  rate  of  five  per  cent  per 
annum,  payable  semi-annually,  January  1 
and  July  1,  there  would  be  attached  to  the 
bond  forty  coupons  of  $25  each.  With 
every  January  1 and  July  1 the  owner 
detaches  from  the  bond  one  of  these  cou- 
pons, and,  upon  presenting  the  same  at 
the  fiscal  agency  of  the  issuing  company, 
receives  $25  in  cash,  representing  the  in- 
terest on  the  $1,000  bond  for  six  months. 
If  the  holder  of  the  coupon  preferred,  he 
could  deposit  the  same  at  his  bank  for  col- 
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a. 

v 

£ 


irtion  of  the  bond  reserved  for 


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lection;  or  a bank  or  trust  company,  to 
whom  he  were  known,  might  arrange  to 
cash  it  for  him.  It  frequently  happens 
that  investors  leave  bonds  in  trust  with 
investment  bankers.  In  this  case,  if  the 
investor  so  directs,  the  banker  will  detach 
the  coupons  upon  the  interest  dates,  collect 
the  same,  and  make  such  disposition  of  the 
proceeds  as  the  client  may  direct.  When 
the  final  coupon  attached  to  a bond  be- 
comes due,  the  bond  itself  should  also  be 
presented  for  payment.  Based  upon  a 
coupon  bond  of  $1,000  denomination,  the 
holder  would  receive  $1,000  in  cash,  rep- 
resenting his  principal,  in  addition  to  the 
$25  in  cash  for  the  last  coupon.  Some- 
times the  final  coupon  is  not  attached  to 
the  bond,  in  which  case,  when  the  bond  is 
presented  for  payment  at  maturity,  the 
holder  receives  also  the  interest  for  the 
last  six  months.  Usually  coupon  bonds 
may  be  registered  as  to  principal,  and,  in 
some  cases,  they  may  be  exchanged  for 
bonds  registered  as  to  both  principal  and 
interest. 


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Coupon  bonds  registered  as  to  princi- 
pal only  are  a direct  obligation  of  the 
issuing  company  to  the  registered  owners. 
Such  bonds  are  not  negotiable,  except  by 
the  written  assignments  of  the  registered 
owners,  whose  names  appear  upon  the 
bonds.  The  coupons  attached  to  such 
bonds,  however,  are  payable  to  bearer,  in 
the  same  manner  as  those  attached  to  cou- 
pon bonds.  Bonds  registered  as  to  prin- 
cipal only,  may  be  released  to  bearer  by 
the  issuing  company,  or  its  agents,  when 
accompanied  by  the  written  assignments 
of  the  registered  owners.  When  so  re- 
leased, they  become  coupon  bonds,  and 
may  be  sold  and  delivered  as  such. 

Bonds  registered  as  to  both  principal 
and  interest  are  a direct  obligation  of  the 
issuing  company  to  the  registered  owners. 
They  are  usually  issued  in  certificate  form, 
assignable  in  writing,  and  have  no  cou- 
pons attached,  checks  for  the  interest 
being  mailed  directly  to  the  registered 
owners.  Practically  all  of  the  modern 
mortgages  provide  for  the  conversion  of 
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such  bonds  into  coupon  bonds.  When 
mortgages  do  not  so  provide,  such  bonds 
usually  sell  at  slightly  lower  prices  than 
coupon  bonds  of  the  same  issuing  com- 
pany, owing  to  the  limited  demand,  and, 
in  the  event  of  sale,  it  is  necessary  to  as- 
sign them  in  blank,  disposing  of  them  spe- 
cifically as  registered  bonds. 

Investors  should  be  very  particular  not 
to  write  their  names,  nor  make  notations, 
upon  bonds.  When  this  is  done,  it  is  nec- 
essary to  sell  them  as  “ endorsed  bonds,” 
which,  of  course,  affects  their  market 
value. 

When  Bonds  Are  Lost 

It  is  obvious  that  coupon  bonds  should 
be  placed  in  a safe-deposit  vault,  or  lodged 
in  some  secure  quarter.  It  is  a matter  of 
record  that  a stolen  coupon  bond,  when 
purchased  by  an  innocent  third  party, 
cannot  be  recovered  by  the  original  own- 
er. Further  than  this,  the  issuing  com- 
pany, or  its  fiscal  agents,  would  ha\e  to 
pay  the  coupons  as  they  became  due,  and 

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also  the  par  value  of  the  bond  at  its  ma- 
turity. This  will  explain  why  many  inves- 
tors prefer  to  leave  bonds  in  trust  with 
their  investment  bankers.  It  is  also  one 
of  the  reasons  why  responsible  investment 
bankers  will  not  buy  or  sell  securities  for 
a stranger,  until  satisfied  that  he  is  all  he 
represents  himself  to  be.  When  a coupon 
bond  is  lost,  the  fiscal  agents  of  the  issu- 
ing company  should  be  notified  promptly, 
and,  if  possible,  the  number  of  the  bond 
furnished.  A communication  should  also 
be  addressed  to  the  investment  banker, 
who  will  render  the  client  every  possible 
assistance  in  the  effort  to  recover  the 
bond.  In  the  case  of  a lost  bond,  the  issu- 
ing company  might,  in  its  discretion,  ar- 
range to  issue  a new  bond,  but  only  upon 
the  filing  of  a satisfactory  bond  of  in- 
demnity. 

In  view  of  these  facts,  it  is  advisable 
for  persons  of  moderate  means,  buying 
bonds  solely  for  investment,  to  have  them 
registered  as  to  principal,  notwithstand- 
ing that  the  coupons  attached  to  the 
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bonds  are  payable  to  bearer,  the  same  as 
in  the  case  of  coupon  bonds.  The  regis- 
tration of  bonds  as  to  principal  is,  how- 
ever, a safeguard  to  the  owners,  so  far  as 
the  principal  is  concerned,  and  such  bonds 
when  released  to  bearer,  in  the  manner  as 
heretofore  stated,  become  readily  nego-  • 
tiable. 

Redeemable  bonds:  In  some  mortgages 
the  right  is  reserved  by  the  issuing  com- 
pany to  buy  all  or  any  part  of  the  out- 
standing bonds  before  maturity,  usually 
upon  prior  notice  to  holders  of  from  one 
to  six  months,  by  advertisement.  This 
naturally  has  an  effect  upon  the  market 
for  such  bonds,  and  explains  why  they 
often  sell  at  lower  prices  than  bonds  which 
are  not  redeemable,  although  the  redeem- 
able bonds  may  bear  the  same  rate  of  in- 
terest and  possess  even  greater  intrinsic 
value.  To  illustrate:  If  a $1,000  bond 
were  redeemable  at  the  option  of  the 
issuing  company  at,  say,  105  ($1,050), 
it  would  be  exceptional  for  a buyer  to 
be  willing  to  pay  in  excess  of  this  figure 


Spencer  Trask  & Co. 

for  the  same.  When  such  bonds  are  re- 
deemed, coupon  bonds  are  payable  to  the 
bearer  at  the  office  of  the  issuing  com- 
pany, or  its  agents ; and  registered  bonds, 
when  accompanied  by  written  assignments, 
are  redeemable  in  the  same  manner.  All 
bonds  cease  to  bear  interest  after  the  date 
of  redemption,  or  maturity. 

Sinking  Fund 

Some  mortgages  provide  that  a certain 
amount  of  cash,  or  a percentage  of  gross 
earnings,  or  so  many  cents  for  each  ton  of 
coal  mined,  etc.,  shall  be  paid  by  the  issu- 
ing company  to  the  trustee  at  stated 
periods,  and  applied  as  a sinking  fund  for 
the  purchase  of  outstanding  bonds,  at  not 
exceeding  a specified  price.  It  is  custom- 
ary to  provide  in  such  mortgages,  that 
the  issuing  company  shall  advertise,  semi- 
annually, or  annually,  as  the  case  may  be, 
the  amount  of  money  in  the  hands  of  the 
trustee  available  for  the  purchase  of  bonds 
for  the  sinking  fund.  The  holders  of  the 
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outstanding  bonds  who  may  so  elect,  offer 
them  to  the  trustee  at  a price  at  which 
they  would  be  willing  to  sell,  not  exceed- 
ing, however,  the  figure  specified  in  the 
mortgage.  When  the  bids  are  opened,  the 
bonds  offered  at  the  lowest  prices  are,  of 
course,  accepted.  If  no  offerings  are  re- 
ceived, the  mortgage  usually  specifies  that 
the  trustees  may  draw  by  lot  a sufficient 
amount  of  the  outstanding  bonds  to  ab- 
sorb the  sinking-fund  money,  paying  the 
holders  the  sinking-fund  price,  no  more 
and  no  less.  The  issuing  company  then 
advertises  the  numbers  of  the  bonds  so 
drawn,  and,  as  far  as  the  holders  are  con- 
cerned, the  principal  and  interest  of  such 
bonds  have  matured.  The  holders  of  the 
drawn  bonds,  upon  presenting  them  at  the 
office  of  the  trustee,  receive  in  payment 
therefor  the  price  specified  in  the  mort- 
gage. In  some  cases,  in  lieu  of  draw- 
ing bonds  by  lot,  the  trustee  may  invest 
and  accumulate  the  sinking-fund  money. 
Bonds  purchased  for  the  account  of  the 
sinking  fund  must  be  either  cancelled  and 
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destroyed,  on  the  one  hand ; or  they  must 
be  kept  alive  and  held  by  the  trustee.  In 
the  latter  case,  the  bonds  continue  to  draw 
interest,  the  same  as  other  outstanding 
bonds,  the  interest  being  applied  by  the 
trustee  toward  the  future  purchase  of 
bonds  for  the  sinking  fund.  Generally 
speaking,  the  mortgages  of  coal  compa- 
nies, or  those  exhausting  a product  which 
cannot  be  replaced,  should  provide  for  a 
sinking  fund,  making  it  certain  that  as  the 
amount  of  coal,  or  whatever  product  it 
may  be,  is  diminished,  the  bonded  debt  of 
the  company  will  be  proportionately  de- 
creased. 

Forms  of  Bonds 

Investors  should  always  ascertain  the 
position  occupied  by  an  issue  of  bonds  with 
respect  to  its  lien  on  the  properties.  For 
example,  among  the  many  different  forms 
of  bonds  may  be  mentioned  the  following: 
First  Mortgage  Bonds, 

First  and  Refunding  Mortgage  Bonds, 
Consolidated  Mortgage  Bonds, 

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Spencer  Trask  & Co. 


General  Mortgage  Bonds, 
Improvement  Mortgage  Bonds, 
Collateral  Trust  Bonds, 

Convertible  Bonds, 

Debenture  Bonds, 

Income  Bonds, 

Short  Term  Notes, 

Equipment  Bonds. 

First  Mortgage  Bonds  are  almost 
always  a first  claim  against  properties. 
Sometimes,  however,  but  only  in  rare 
cases,  bonds  bearing  the  title  of  “ first 
mortgage  99  are  a first  lien  on  only  a part 
of  the  property,  being  subject  on  the  re- 
maining property  to  underlying  or  prior 
bonds,  for  the  retirement  of  which  a suffi- 
cient amount  of  the  first  mortgage  bonds 
may  be  reserved. 

First  and  Refunding  Mortgage  Bonds, 
Consolidated  Mortgage  Bonds,  and  Gen- 
eral Mortgage  Bonds,  are  ordinarily  a 
first  mortgage  on  some  part  of  the  prop- 
erties, and  may  become  ultimately  a first 
mortgage  on  all  of  the  properties  covered 

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by  the  deed  of  trust,  as  the  underlying 
bonds  become  due  and  payable. 

Improvement  Mortgage  Bonds,  as  their 
title  implies,  are  issued  for  special  im- 
provements, and  are  usually  a direct  mort- 
gage on  the  properties,  subject  to  the 
underlying  bonds. 

Collateral  Trust  Bonds  may  be  secured 
by  pledge  of  stock  with  the  Trustee,  or 
by  pledge  of  both  stock  and  bonds.  Some- 
times, they  are  additionally  secured  by  a 
direct  lien  upon  the  properties. 

Convertible  bonds  are  usually  a direct 
obligation  of  the  issuing  corporation,  at  a 
fixed  rate  of  interest,  although,  in  some 
cases,  they  are  also  a lien  upon  the  prop- 
erties. The  holders  have  the  right  to  con- 
vert the  bonds  into  stock  within  a specified 
time  and  on  stated  terms. 

Debenture  Bonds  are  usually  simply  an 
obligation  of  the  issuing  corporation,  but 
it  is  sometimes  provided  that  they  shall 
rank  equally  as  to  lien  on  the  properties 
with  any  future  mortgage  that  the  cor- 
poration may  authorize. 

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Income  bonds,  as  their  title  implies,  only 
receive  interest  when  the  earnings  have 
been  sufficient  to  justify  the  payment  of 
the  same. 

Many  holders  of  real  estate  debenture 
bonds  or  income  bonds  do  not  perhaps  ap- 
preciate that  they  are  simply  an  obliga- 
tion issued  against  equities,  and  their 
safety  dependent  almost  wholly  upon  the 
success  of  the  company.  This  is  why  bonds 
of  this  type  are  to  be  regarded  as  semi- 
speculative. 

Short  Term  Notes  are  issued  by  cor- 
porations either  during  periods  of  high 
interest  rates  or  at  other  times  when 
long-term  bonds  cannot  be  sold  at  reason- 
able prices.  They  represent  a temporary 
method  of  financing,  and  are  a direct 
obligation  of  the  issuing  corporation. 
Sometimes,  they  are  secured  by  pledge  of 
collateral  with  the  Trustee,  and  in  a few 
cases  are  guaranteed  as  to  principal,  or  as 
to  both  principal  and  interest. 

Car  Trusts,  Equipment  Bonds  and 
Equipment  Notes  are  issued  to  pay  for 

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Spencer  Trask  & Co. 


equipment,  and  are  ordinarily  paid  off 
serially,  or  by  installments.  Usually,  all 
of  the  equipment  is  pledged  as  collateral 
until  the  last  installment  is  paid.  Thus, 
the  security  for  the  remaining  bonds  or 
notes  enhances  with  the  reduction  of  the 
amount  outstanding. 

“ And  Interest 99  Prices 

All  interest-bearing  bonds  listed  upon 
the  New  York  Stock  Exchange  are  dealt 
in  “and  interest.”  The  commission  charge 
is  -J  of  one  per  cent  of  the  par  value,  or 
$1.25  for  each  $1,000  bond. 

Buyers  of  unlisted  bonds  are  not  usu- 
ally charged  a commission,  although  there 
are  exceptions  to  this  rule.  Such  bonds, 
however,  usually  sell  at  a given  price 
“ and  interest  ” in  the  same  manner  as 
listed  bonds.  This  means  that  the  buyer 
pays  the  accrued  interest  from  the  date  of 
the  last  paid  coupon  up  to,  but  not  in- 
cluding, the  date  of  payment  for  the  bond. 
To  illustrate:  Assume  that  on  April  1 an 
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Spencer  Trask  & Co. 


investor  paid  for  a $1,000  five  per  cent 
bond  at  cost  of,  say,  98^  and  interest , the 
coupons  attached  to  the  bond  being  pay- 
able January  1 and  July  1.  A statement 
would  be  rendered,  as  follows: 

$1,000  5 per  cent,  bond  at  98^,  $985.00 
Accrued  interest  from  Jan.  1 to 

Apr.  1,  at  the  coupon  rate,  12.50 

Cost  of  unlisted  bond,  $997.50 

If  the  order  had  been  executed 
on  the  New  York  Stock  Ex- 
change, add  ^ of  one  per  cent, 
commission,  1.25 


Cost  of  listed  bond,  $998.75 

On  July  1 the  owner  of  the  $1,000  bond 
would  cash  the  $25  coupon,  and  thus  be 
reimbursed  the  $12.50  paid  as  accrued 
interest  from  January  1 to  April  1.  The 
remaining  $12.50  would  represent  interest 
at  the  coupon  rate  from  April  1 to  June 
30,  inclusive,  during  which  period  the 
bond  was  actually  owned  by  the  buyer. 

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Payment  and  Delivery  of  Bonds 

When  purchasing  investment  securities, 
so  far  as  the  initial  transaction  is  con- 
cerned, it  is  customary  for  buyers  to  fur- 
nish satisfactory  references,  preferably  a 
bank  reference.  It  is  also  the  custom, 
when  bonds  are  purchased  by  persons  re- 
siding in  other  sections  of  the  country, 
for  the  investment  bankers  to  receive  pay- 
ment therefor,  and  make  delivery  thereof, 
by  one  of  the  three  following  methods: 

1.  The  bonds  may  be  forwarded  to  the 
buyer,  either  by  registered  mail  or  ex- 
press, after  the  investment  house  has  re- 
ceived payment  therefor.  This  is  the 
prevailing  method  when  executing  orders 
for  the  purchase  of  bonds  through  New 
York  Stock  Exchange  firms.  In  such 
cases,  the  buyer  should  make  remittance  in 
funds  payable  in  New  York  City,  the  day 
following  the  purchase,  excepting  on  Fri- 
days, when  payment  should  be  made  the 
following  Monday.  The  reason  for  this 
is,  that  the  broker,  who  acts  merely  as  an 
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Spencer  Trask  & Co. 


agent  in  the  transaction,  is  required  to 
make  payments  in  this  same  way  and  man- 
ner, and  the  buyer  should,  therefore,  be 
governed  accordingly. 

2.  The  bonds  may  be  forwarded  to  the 
buyer,  accompanied  by  a draft  for  the 
amount  of  their  cost,  delivery  being  made 
upon  payment  of  the  draft. 

3.  The  bonds  may  be  forwarded  to 
any  bank  designated  by  the  buyer,  deliv- 
ery being  made  upon  payment  of  the 
amount  due. 

In  all  three  cases,  it  is  customary  for 
investment  bankers  to  receive  remittances 
at  some  bank  in  the  city  where  they  trans- 
act their  business ; otherwise,  it  is  the  cus- 
tom for  the  buyer  to  pay  the  collection 
charges. 


31 


CHAPTER  III 


MANAGEMENT  OF  CORPORATIONS 

Broadly  speaking,  the  management  of 
corporations  may  be  divided  into  two 
parts : 

First — the  duties  of  the  directors,  who 
are  responsible  to  the  stockholders,  by 
whom  they  are  elected  to  office,  and  whose 
best  interests  they  should  always  aim  to 
safeguard. 

Second — the  duties  of  the  operating 
officials,  who  are  accountable  to  the  direc- 
tors for  the  conduct  of  the  business. 

However,  as  many  of  the  directors, 
while  keeping  in  close  touch  with  the 
progress  of  the  business,  are  not  always 
familiar  with  all  of  the  details,  it  is  cus- 
tomary for  some  of  the  operating  officials 
to  be  included  in  the  directorate. 

The  directors,  as  a body,  must  see  to 

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Spencer  Trask  & Co. 

it  that  the  business  be  properly  conducted ; 
the  credit  and  financial  standing  of  the 
company  well  safeguarded;  the  physical 
condition  of  the  property  amply  main- 
tained; in  fact,  that  every  precaution  be 
taken  to  protect  the  invested  capital. 

The  operating  officials,  on  the  other 
hand,  have  more  to  do  with  the  actual  con- 
duct of  the  business ; the  details  of  manu- 
facturing, the  creation  of  an  effective 
distributing  organization,  which,  to  be 
successful,  must  not  only  secure  new  cus- 
tomers, but  retain  the  good-will  of  the  old. 
Summed  up,  this  means  an  expanding  and 
profitable  business. 

From  this  it  becomes  evident  that  no 
matter  how  great  may  be  the  true  value 
of  a property,  the  development  of  its  earn- 
ing power  is  really  dependent  upon  good 
management.  The  gross  earnings  must 
be  sufficient  to  defray  the  cost  of  opera- 
tion, as  also  to  pay  interest,  taxes,  in- 
surance and  other  fixed  charges.  A cor- 
poration failing  to  do  all  these  things  is 
on  the  road  to  serious  trouble.  The  in- 
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Spencer  Trask  & Co. 


terest  on  bonds  must  be  paid.  If  not,  a 
receivership  is  almost  inevitable.  There- 
fore, a competent  management  will  aim  to 
keep  fixed  charges  reduced  to  a minimum. 
Moreover,  in  years  of  prosperity,  some 
part  of  surplus  earnings  should  be  set 
aside  as  a reserve  fund,  thus  fortifying  the 
business  against  adverse  conditions. 

Rights  of  Common  Stockholders 

It  should  be  borne  in  mind,  however, 
that  the  common  stockholders,  whose  claim 
against  assets  or  earnings,  is  subject  to 
that  of  the  bondholders,  and  in  most  cases 
to  that  of  the  preferred  stockholders,  are 
entitled  to  a fair  proportion  of  the  surplus 
earnings.  This  will  be  more  readily  ap- 
preciated when  it  is  remembered  that  com- 
mon stockholders,  especially  those  of  large 
corporations,  often  furnish  additional 
capital  for  the  expansion  of  the  business, 
or  the  enlargement  of  plant  facilities. 
For  example,  when  corporations  need 
money,  it  is  not  an  unusual  custom  to 
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Spencer  Trask  & Co. 

offer  stockholders  the  opportunity  of  pur- 
chasing an  additional  amount  of  common 
stock  on  a pro-rata  basis,  and  at  a lower 
figure  than  the  price  for  which  it  sells  in 
the  open  market.  While  this  is  ordinarily 
regarded  as  a valuable  privilege,  the  fact 
remains  that  the  additional  money  in- 
vested is  entitled  to  a fair  dividend  return. 
Its  expenditure  enhances  the  value  of  the 
properties,  and  affords  a larger  equity  for 
the  protection  of  the  holders  of  the  bonds, 
preferred  stock,  or  other  securities  having 
priority  over  the  common  stock  as  to  as- 
sets and  dividends. 

Surplus  Reserve 

One  of  the  most  perplexing  problems 
that  directors  have  to  solve  is  just  what 
proportion  of  surplus  earnings  should  go 
back  into  the  property,  or  be  set  aside  as 
a surplus  reserve.  In  many  cases,  opera- 
ting officials  want  practically  all  of  the 
surplus  earnings  put  back  into  the  prop- 
erty, and  are  opposed  to  any  distribution 
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Spencer  Trask  & Co. 

to  the  common  stockholders.  But  the  di- 
rectors, who,  as  already  explained,  are 
elected  by  the  stockholders,  are  in  duty 
bound  to  see  that  an  equitable  disburse- 
ment is  made,  and  if  no  dividends  are  paid 
in  any  year  when  a good  surplus  has  been 
earned,  some  explanation  is  due  the  stock- 
holders. Ordinarily,  it  is  wise  to  distribute 
to  common  stockholders,  approximately, 
fifty  per  cent,  of  annual  surplus  earnings, 
but  this  is  not  always  feasible  or  practi- 
cable. 

Sometimes,  stockholders  are  most  un- 
reasonable in  their  demands,  and  if  dis- 
satisfied with  dividend  disbursements,  will 
sell  their  holdings  and  reinvest  in  the 
shares  of  other  corporations.  This  con- 
dition is  likely  to  have  a temporarily  bad 
effect  on  the  market  price  of  the  stock.  If 
additional  capital  were  needed  in  the 
business  when  securities  were  declining 
in  market  value,  the  corporation  would, 
in  all  probability,  have  to  sell  its  bonds  or 
stocks  at  lower  prices  than  those  war- 
ranted by  their  true  value.  Thus,  every- 
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Spencer  Trask  & Co. 

thing  within  reason  must  be  done  to  main- 
tain credit  and  financial  standing.  This 
will  explain  why  directors  are  sometimes 
influenced  to  be  too  liberal  in  the  dis- 
bursement of  dividends  during  times  of 
good  prosperity,  with  the  result  that  pay- 
ments are  likely  to  be  reduced,  or  per- 
haps suspended,  when  a general  business 
reaction  takes  place.  When  the  period 
of  depression  comes,  however,  as  it  always 
does,  the  conservatively  managed  corpora- 
tion, whose  directors  have  accumulated  a 
good  surplus  reserve,  is  in  a position  to 
continue  regular  dividend  disbursements, 
and  has  the  complete  confidence  of  its 
stockholders. 

All  these  things  go  to  prove  how  im- 
portant and  complex  are  the  duties  of 
directors.  There  is  practically  no  limit  to 
their  legitimate  powers.  They  are  re- 
sponsible for  the  entire  business  and  finan- 
cial policy  of  a corporation,  and  may 
either  carry  it  to  the  height  of  prosperity, 
or  hamper  and  retard  its  progress.  When 
we  stop  to  consider  the  magnitude  of  the 
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Spencer  Trask  & Co. 


corporate  interests  of  this  country,  and 
the  difficulties  to  be  overcome  in  the 
growth  and  development  of  properties,  it 
must  be  apparent  to  fair-minded  people 
that  directors,  as  a whole,  measure  up  to 
the  standard  of  their  responsibilities. 


/ 


38 


CHAPTER  IV 


PREFERRED  STOCKS 

There  is  a growing  tendency  on  the 
part  of  those  responsible  for  the  manage- 
ment of  industrial  corporations  to  obtain 
capital  requirements  through  the  issue 
and  sale  of  preferred  stock.  When  securi- 
ties of  this  type  are  issued  against  estab- 
lished and  skillfully  managed  businesses, 
and  underwritten  by  large  and  responsible 
investment  firms,  they  are  regarded  as 
thoroughly  sound  investments,  well  adapt- 
ed to  the  needs  of  people  who  feel  that  they 
must  secure  the  highest  rate  of  interest  on 
their  money  compatible  with  safety,  or  a 
return  approaching  seven  per  cent.  On 
the  other  hand,  they  are  more  or  less  at- 
tractive to  investors  of  large  means,  who 
may  be  for  the  most  part  buyers  of  bonds, 
but  who  adopt  the  plan  of  placing  some 
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Spencer  Trask  & Co. 

part  of  their  money  in  preferred  stocks  of 
high  standard,  thereby  increasing  their 
average  income. 

Diversification  of  Investments 

This  is  in  line  with  judicious  invest- 
ment, as  a result  of  which  investors  come 
to  appreciate  the  wisdom  of  diversifying 
their  holdings,  both  as  to  type  of  security 
and  geographical  location  of  the  prop- 
erties. By  this  method,  investors  increase 
the  average  return  on  their  money,  and 
also  fortify  themselves  against  adverse 
conditions,  which  might  otherwise  affect 
only  the  one  type  of  investment,  or  the 
particular  section  of  the  country,  in  which 
all  of  their  money  were  employed.  Thus, 
it  becomes  obvious  that  diversification  is 
essential  to  judicious  investment. 

Best  Issues  of  Preferred  Stocks 

While  it  is  impossible  to  lay  down  any 
fixed  rule  for  the  guidance  of  people  in- 
vesting in  preferred  stocks  of  this  type, 
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Spencer  Trask  & Co. 


it  is  ordinarily  true  that  the  best  issues  are 
surrounded  by  the  following  safeguards: 

First:  Preferred  both  as  to  assets  and 
dividends  over  common  stock. 

Second:  No  dividends  to  be  paid  on  the 
common  in  any  year  until  all  accumulated 
dividends  have  been  paid  on  the  preferred. 

Third:  No  mortgage  or  bonded  indebt- 
edness, and  none  to  be  created  in  the  fu- 
ture except  with  the  consent  of  at  least 
a majority  of  the  preferred  stock  out- 
standing. 

Fourth:  Net  quick  assets,  [comprising 
only  cash,  accounts  and  bills  receivable, 
and  fair  inventory  value  of  raw  material 
and  manufactured  products]  equal  to  at 
least  the  amount  of  the  preferred  stock 
outstanding. 

Fifth:  Ownership  by  the  management 
of  practically  all  of  the  common  stock, 
which  insures  its  personal  interest  in  the 
successful  and  profitable  expansion  of  the 
business. 

Sixth:  After  the  common  has  received 
reasonably  liberal  dividends  in  any  one 
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Spencer  Trask  & Co. 


year,  some  portion  of  surplus  earnings 
should  be  set  aside  as  a reserve  fund, 
either  for  betterments  and  additions,  or, 
at  the  discretion  of  the  directors,  for  the 
retirement  of  a part  of  the  preferred  stock 
outstanding. 

The  record  of  earnings  is,  of  course,  of 
vital  importance.  Generally  speaking,  the 
net  earnings  should  average  for  a period 
of  years  from  two  to  three  times  the  an- 
nual dividend  requirements  on  the  pre- 
ferred stock  outstanding,  including  the 
stock  immediately  to  be  issued  and  offered 
investors.  Moreover,  it  is  essential  that 
the  value  of  the  plants  and  properties  be 
appraised  by  independent  experts,  the 
books  and  accounts  audited  by  certified 
public  accountants,  and  the  legality  of  the 
issue  of  the  preferred  stock  passed  upon  by 
well-known  attorneys.  It  can  be  stated  as 
a fact  that  no  responsible  investment  firm 
would  offer  an  issue  of  preferred  stock  to 
its  clients  until  all  of  these  matters  had 
been  thoroughly  and  satisfactorily  inves- 
tigated. 

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Spencer  Trask  & Co. 

This  explanation  of  investment  should 
make  it  clear  that  the  selection  of  sound 
and  profitable  securities  is  not  in  any  sense 
a difficult  problem,  provided  your  knowl- 
edge of  the  subject  is  sufficient  to  enable 
you  to  take  advantage  of  the  suggestions, 
or  advice,  of  a responsible  investment  firm. 
The  more  study  you  give  the  subject,  the 
greater  will  become  your  conviction  that 
the  success  of  well-informed  investors  is 
due,  for  the  most  part,  to  the  efficiency 

of  the  organization  of  their  investment 
bankers. 


